Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2016

¨

Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number 000-52170

________________________________________

INNERWORKINGS, INC.

(Exact Name of Registrant as Specified in its Charter)

________________________________________

Delaware

20-5997364

(State or Other Jurisdiction of

(I.R.S. Employer

Incorporation or Organization)

Identification No.)

600 West Chicago Avenue, Suite 850

Chicago, Illinois 60654

Phone: (312) 642-3700

(Address, zip code and telephone number, including area code, of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes:
ý
No:
¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes:
ý
No:
¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check one:

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes:
¨
No:
ý

As of
August 8, 2016
, the Registrant had
54,764,676
shares of Common Stock, par value $0.0001 per share, outstanding, which includes 1,169,103 shares of unvested restricted stock awards that have voting rights and are held by members of the Board of Directors and certain of the Company’s employees.

See accompanying notes to the condensed consolidated financial statements.

5

InnerWorkings, Inc. and subsidiaries

Condensed Consolidated Statement of Cash Flows

(In thousands)

(Unaudited)

Six Months Ended June 30,

2016

2015

(as revised)

Cash flows from operating activities

Net income (loss)

$

(5,017

)

$

3,930

Adjustments to reconcile net income (loss) to net cash used in operating activities:

Depreciation and amortization

9,316

8,357

Stock-based compensation expense

2,358

3,628

Deferred income taxes

450

1,366

Bad debt provision

789

1,049

Change in fair value of contingent consideration

9,187

990

Other operating activities

105

104

Change in assets:

Accounts receivable and unbilled revenue

(2,366

)

(10,311

)

Inventories

(2,573

)

(10,845

)

Prepaid expenses and other assets

16,255

720

Change in liabilities:

Accounts payable

(33,984

)

5,973

Accrued expenses and other liabilities

4,632

(3,974

)

Net cash provided by (used in) operating activities

(848

)

987

Cash flows from investing activities

Purchases of property and equipment

(7,445

)

(8,656

)

Net cash used in investing activities

(7,445

)

(8,656

)

Cash flows from financing activities

Net borrowings from revolving credit facilities

12,553

7,396

Net short-term secured borrowings

104

669

Repurchases of common stock

—

(4,897

)

Payments of contingent consideration

(4,144

)

(2,177

)

Proceeds from exercise of stock options

1,090

599

Other financing activities

(474

)

(179

)

Net cash provided by financing activities

9,129

1,411

Effect of exchange rate changes on cash and cash equivalents

15

(754

)

Increase (decrease) in cash and cash equivalents

851

(7,012

)

Cash and cash equivalents, beginning of period

30,755

22,578

Cash and cash equivalents, end of period

$

31,606

$

15,566

See accompanying notes to the condensed consolidated financial statements.

6

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

1. Summary of Significant Accounting Policies

Revision

The Company has revised herein its audited consolidated financial statements for the annual periods ended December 31, 2013, December 31, 2014 and December 31, 2015 and its unaudited condensed consolidated interim periods ended March 31, 2014, June 30, 2014, September 30, 2014, December 31, 2014, March 31, 2015, June 30, 2015, September 30, 2015, December 31, 2015 and March 31, 2016. See Note 15 – Revision to Correct Immaterial Error in Previously Issued Financial Statements for additional information.

Basis of Presentation of Interim Financial Statements

The accompanying unaudited condensed consolidated financial statements of InnerWorkings, Inc. and subsidiaries (the “Company”) included herein have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (“SEC”) and accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation of the accompanying unaudited financial statements have been included, and all adjustments are of a normal and recurring nature. The operating results for the
three and six
months ended
June 30, 2016
are not necessarily indicative of the results to be expected for the full year ending
December 31, 2016
. These condensed interim consolidated financial statements and notes should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto as of and for the year ended
December 31, 2015
included in the Company’s Annual Report on Form 10-K filed with the SEC on March 10, 2016.

Description of the Business

InnerWorkings, Inc. (together with its subsidiaries, the "Company”) was incorporated in the state of Delaware on January 3, 2006. The Company is a leading global marketing execution firm for the world's most marketing intensive companies, including those in the Fortune 1000, across a wide range of industries. As a comprehensive outsourced enterprise solution, the Company leverages proprietary technology, an extensive supplier network and deep domain expertise to streamline the creation, production, and distribution of marketing and promotional materials, signage and displays, retail experiences, events and promotions, and packaging across every major market worldwide. The items the Company sources are generally procured through the marketing supply chain, and are referred to collectively as marketing materials. The Company’s technology and database of information is designed to capitalize on excess manufacturing capacity and other inefficiencies in the traditional marketing and print supply chain to obtain favorable pricing and to deliver high-quality products and services.

The Company is organized and managed as
two
business segments, North America and International, and is viewed as
two
operating segments by the chief operating decision maker for purposes of resource allocation and assessing performance. See Note 14 for further information about the Company’s reportable segments.

Preparation of Financial Statements and Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. On an ongoing basis, the Company evaluates its estimates, including those related to product returns, allowance for doubtful accounts, inventories and inventory valuation, valuation and impairments of goodwill and long-lived assets, income taxes, accrued bonus, contingencies, stock-based compensation and litigation. The Company bases its estimates on historical experience and on other assumptions that its management believes are reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of assets and liabilities when those values are not readily apparent from other sources. Actual results can differ from those estimates.

Foreign Currency Translation

7

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

The Company determines the functional currency for its parent company and each of its subsidiaries by reviewing the currencies in which their respective operating activities occur. Assets and liabilities of these operations are translated into U.S. currency at the rates of exchange at the balance sheet date. Income and expense items are translated at average monthly rates of exchange. The resulting translation adjustments are included in accumulated other comprehensive loss, a separate component of stockholders’ equity. Transaction gains and losses arising from activities in other than the applicable functional currency are calculated using average exchange rates for the applicable period and reported in net income as a non-operating item in each period. Non-monetary balance sheet items denominated in a currency other than the applicable functional currency are translated using the historical rate.

Revenue Recognition

The Company recognizes revenue upon meeting all of the following revenue recognition criteria, which are typically met upon shipment or delivery of its products to customers: (i) persuasive evidence of an arrangement exists through customer contracts and orders, (ii) the customer takes title and assumes the risks and rewards of ownership, (iii) the sales price charged is fixed or determinable as evidenced by customer contracts and orders, and (iv) collectability is reasonably assured. Unbilled revenue relates to shipments that have been made to customers for which the related account receivable has not yet been billed.

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-45,
Revenue Recognition – Principal Agent Considerations
, the Company generally reports revenue on a gross basis because the Company is the primary obligor in its arrangements to procure marketing materials and other products for its customers. Under these arrangements, the Company is responsible for the fulfillment, including the acceptability, of the marketing materials and other products. In addition, the Company (i) determines which suppliers are included in its network, (ii) has discretion to select from among the suppliers within its network, (iii) is obligated to pay its suppliers regardless of whether it is paid by its customers, and (iv) has reasonable latitude to establish exchange price. In some transactions, the Company also has general inventory risk and is involved in the determination of the nature or characteristics of the marketing materials and products. When the Company is not the primary obligor, revenues are reported net.

The Company recognizes revenue for creative and other services provided to its customers which may be delivered in conjunction with the procurement of marketing materials at the time when delivery and customer acceptance occur and all other revenue recognition criteria are met. The Company recognizes revenue for creative and other services provided on a stand-alone basis upon completion of the service. Service revenue has not been material to the Company’s overall revenue to date.

Stock-Based Compensation

The Company accounts for stock-based compensation awards to employees and directors in accordance with ASC 718,
Compensation – Stock Compensation
. Compensation expense is measured by determining the fair value of each award using the Black-Scholes option valuation model for stock options or the closing share price for restricted shares. The fair value is then recognized over the requisite service period of the awards, which is generally the vesting period, on a straight-line basis for the entire award.

Stock-based compensation cost recognized during the period is based on the portion of the share-based payment awards that are ultimately expected to vest. Accordingly, stock-based compensation cost recognized has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The Company recorded
$1.1 million
and
$1.6 million
in stock-based compensation expense for the
three months ended June 30, 2016
and 2015, respectively, and
$2.4 million
and
$3.6 million
in stock-based compensation expense for the
six months ended June 30, 2016
and 2015, respectively. During the first quarter of 2015,
$0.4 million
of stock-based compensation expense was recognized related to the modification of a former executive’s award agreements in connection with his transition agreement.

Recent Accounting Pronouncements

8

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

In March 2016, the FASB issued Accounting Standards Update No. 2016-09,
Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
, ("ASU 2016-09") which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for annual and interim periods beginning after December 15, 2016. This guidance can be applied either prospectively, retrospectively or using a modified retrospective transition method. Early adoption is permitted.
The Company is currently evaluating the impact of adopting this standard
on its consolidated financial statements
.

In March 2016, the FASB issued Accounting Standards Update No. 2016-08,
Revenue from Contracts with Customers (Topic 606) Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net),
("ASU 2016-08") and in April 2016, the FASB issued Accounting Standards Update No. 2016-10,
Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
("ASU 2016-10"), both of which provide supplemental adoption guidance and clarification to ASC 2014-09. ASU 2016-08 and ASU 2016-10 must be adopted concurrently with the adoption of ASU 2014-09.
The Company is currently evaluating the impact of adopting these standards
on its consolidated financial statements
.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02,
Leases (Topic 842)
, ("ASU 2016-02") which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosure of key information about leasing arrangements. ASU 2016-02 requires lessees to recognize a right-of-use asset and a lease liability for most leases in the balance sheet as well as other qualitative and quantitative disclosures. The update is to be applied using a modified retrospective method and is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods.
The Company is currently evaluating the impact of adopting this standard
on its consolidated financial statements
.

In May 2014, the FASB issued Accounting Standards Update 2014-09,
Revenue from Contracts with Customers (Topic 606)
(“ASU 2014-09”), which amends the existing accounting standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers.
In August 2015, the FASB issued Accounting Standards Update 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
(
“
ASU 2015-14
”
) which defers the effective date of ASU 2014-09 for all entities by one year.
Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.
The Company is currently evaluating the impact of adopting these standards
on its consolidated financial statements
.

In July 2015, the FASB issued
Accounting Standards Update
2015-11,
Inventory (Topic 330): Simplifying the Measurement of Inventory
(
“A
SU 2015-11
”
). ASU 2015-11 applies to inventory that is measured using first-in, first-out (FIFO) or average cost. Under the updated guidance, an entity should measure inventory that is within scope at the lower of cost and net realizable value, which is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged for inventory that is measured using last-in, last-out (LIFO). The standard is effective for annual and interim periods beginning after December 15, 2016, and should be applied prospectively with early adoption permitted at the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of adopting ASU 2015-11
on its consolidated financial statements
.

In August 2014, the FASB issued Accounting Standards Update 2014-15,
Presentation of Financial Statements – Going Concern
(“ASU 2014-15”). ASU 2014-15 requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity's ability to continue as a going concern and to provide disclosures in certain circumstances. The standard is effective for annual periods ending after December 15, 2016 and interim periods beginning on or after December 15, 2016. The Company does not expect ASU 2014-15 to have a material impact on its consolidated financial statements.

2. Contingent Consideration

In connection with certain of the Company’s acquisitions, contingent consideration is payable in cash or common stock upon the achievement of certain performance measures over future periods. The Company recorded the acquisition date fair value of the contingent consideration liability as additional purchase price. As discussed in Note 10, the process for determining the fair value of the contingent consideration liability consists of reviewing financial forecasts and assessing the likelihood of reaching the required performance measures based on factors specific to each acquisition as well as the Company’s historical experience with similar arrangements. Subsequent to the acquisition date, the Company estimates the fair value of the contingent consideration liability each reporting period, and any adjustments made to the fair value are recorded in the Company’s results of operations. If an acquisition reaches the required performance measures within the reporting period, the fair value of the contingent consideration liability is increased to
100%
, the maximum potential payment, and reclassified to Due to seller.

The Company has recorded
$18.6 million
in contingent consideration at
June 30, 2016
related to these arrangements. Any adjustments made to the fair value of the contingent consideration liability subsequent to the acquisition date will be recorded in the Company’s results of operations. During the
three months ended June 30, 2016
and
2015
, the Company recorded expense

9

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

of
$7.3 million
and
$0.7 million
, respectively. During the
six months ended June 30, 2016
and
2015
, the Company recorded expense of
$9.2 million
and
$1.0 million
, respectively.

For the
three and six
months ended
June 30, 2016
, the Company's fair value adjustment to the contingent consideration liability includes an adjustment of
$7.4 million
and
$8.1 million
, respectively, of expense to increase the liability relating to the Eyelevel acquisition due to strong financial performance in recent periods and an increase in forecasted results. This improved performance was primarily driven by significant expansion within its existing customer base in the first half of 2016. As a result of this growth and the increase in forecast, the probability of Eyelevel achieving the target threshold for the final earnout measurement period increased from less than probable to highly probable. This probability change was the primary driver of the increase in the fair value of the contingent consideration liability. The large increase in fair value resulting from the probability change also takes in to account the acquisition agreement's earnout payment structure for the final measurement period, which begins funding at
$12.0 million
based on cumulative EBITDA of
$30.0 million
but pays nothing below that threshold.

As of
June 30, 2016
, the potential maximum contingent payments, excluding the amounts recorded in Due to seller which are currently payable, would be due as follows if all performance measures are achieved (in thousands):

Maximum Potential Payment

Fair Value of Liability

2016

$

1,153

$

66

2017

70,553

18,494

$

71,706

$

18,560

If the performance measures required by the purchase agreements are not achieved, the Company may pay less than the maximum amounts presented in the table above, depending on the terms of the agreement. While the maximum potential payments shown in the table are
$71.7 million
, the Company estimates that the fair value of the payments that will be made is
$18.6 million
.

3. Goodwill

The following is a summary of the goodwill balance for each reportable segment as of
June 30, 2016
(in thousands):

North America

International

Total

Net goodwill as of December 31, 2015

$

170,735

$

35,522

$

206,257

Foreign exchange impact

43

(1,403

)

(1,360

)

Net goodwill as of June 30, 2016

$

170,778

$

34,119

$

204,897

Goodwill represents the excess of purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. In accordance with ASC 350,
Intangibles – Goodwill and Other
("ASC 350"), goodwill is not amortized, but instead is tested for impairment annually, or more frequently if circumstances indicate a possible impairment may exist. Absent any interim indicators of impairment, the Company tests for goodwill impairment as of the first day of the fourth fiscal quarter of each year.

The fair value estimates used in the goodwill impairment analysis require significant judgment. The Company's fair value estimates for purposes of performing the analysis are considered Level 3 fair value measurements. The fair value estimates were based on assumptions that management believes to be reasonable, but that are inherently uncertain, including estimates of future revenues and operating margins and assumptions about the overall economic climate and the competitive environment for the business.

The Company reviews for potential impairment indicators each reporting period and does not believe that goodwill is impaired as of
June 30, 2016
.

4.
Other Intangible Assets

The following is a summary of the Company’s other intangible assets as of
June 30, 2016
and
December 31, 2015
(in thousands):

10

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

June 30,
2016

December 31, 2015

Weighted

Average Life

Customer lists

$

73,590

$

73,759

13.6

Noncompete agreements

962

988

4.1

Trade names

3,160

3,228

12.6

Patents

57

57

9.0

77,769

78,032

Less accumulated amortization

(42,938

)

(40,317

)

Intangible assets, net

$

34,831

$

37,715

In accordance with ASC 350, the Company amortizes its intangible assets with finite lives over their respective estimated useful lives and reviews for impairment whenever impairment indicators exist. Impairment indicators could include significant under-performance relative to the historical or projected future operating results, significant changes in the manner of use of assets, significant negative industry or economic trends or significant changes in the Company’s market capitalization relative to net book value. Any changes in key assumptions used by the Company, including those set forth above, could result in an impairment charge and such a charge could have a material adverse effect on the Company’s consolidated results of operations. The Company’s intangible assets consist of customer lists, noncompete agreements, trade names and patents. The Company’s customer lists, which have an estimated weighted-average useful life of approximately fourteen years, are being amortized using the economic life method. The Company’s noncompete agreements, trade names and patents are being amortized on a straight-line basis over their estimated weighted-average useful lives of approximately four years, thirteen years and nine years, respectively.

Amortization expense related to these intangible assets was
$1.4 million
and
$1.4 million
for the
three months ended June 30, 2016
and
2015
, respectively, and
$2.7 million
and
$2.9 million
for the
six months ended June 30, 2016
and
2015
, respectively.

The estimated amortization expense for the remainder of 2016 and each of the next five years and thereafter is as follows (in thousands):

Remainder of 2016

$

2,682

2017

5,098

2018

4,607

2019

4,316

2020

4,239

Thereafter

13,889

$

34,831

5. Restructuring Activities and Other Charges

2016
:
On December 14, 2015, the Company approved a global realignment plan that is expected to allow the Company to more efficiently meet client needs across its international platform. Through improved integration of global resources, the plan will create back office and other efficiencies and allow for the elimination of approximately
100
positions. In connection with these actions, the Company expects to incur total pre-tax cash restructuring charges of
$5.5 million
to
$5.9 million
, the majority of which will be recognized during 2016. These cash charges will include approximately
$4.5 million
to
$4.7 million
for employee severance and related benefits and
$1.0 million
to
$1.2 million
for lease and contract termination and other associated costs. As required by law, the Company is consulting with each of the affected countries’ local Works Councils throughout implementation of this plan.

As of
June 30, 2016
, the Company has recognized
$5.0 million
in restructuring charges related to this plan, of which
$0.3 million
,
$3.9 million
and
$0.8 million
related to the North America, International and Other segments, respectively. This plan is expected to be completed during 2016.

11

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

The following table summarizes the accrued restructuring activities for this plan for the
six months ended June 30, 2016
(in thousands):

Employee Severance and Related Benefits

Lease and Contract Termination Costs

Total

Balance at December 31, 2015

$

284

$

75

$

359

Charges

3,105

862

3,967

Cash payments

(2,282

)

(63

)

(2,345

)

Balance at June 30, 2016

$

1,107

$

874

$

1,981

2015
:
No
restructuring activities occurred during the
six months ended June 30, 2015
.

6. Income Taxes

The Company's tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items. The Company’s reported effective income tax rate was
702.0%
and
37.4%
for the
three months ended June 30, 2016
and
2015
, respectively, and
(2,038.9)%
and
39.9%
for the
six months ended June 30, 2016
and
2015
, respectively. The Company’s effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.

The effective tax rates were affected by the fair value changes to contingent consideration in each period. Portions of the total amount recognized from fair value changes to contingent consideration relate to non-taxable acquisitions for which deferred taxes are not recognized, consistent with the treatment of goodwill and intangible assets for those acquisitions under U.S. GAAP. In the
three months ended June 30, 2016
and
2015
,
$7.3 million
and
$0.7 million
, respectively, was recognized as expense from fair value changes to contingent consideration, and in the
six months ended June 30, 2016
and
2015
,
$9.2 million
and
$1.0 million
, respectively, was recognized as expense from fair value changes to contingent consideration, which did not result in recognition of a deferred tax asset, therefore, increasing the effective tax rate for these periods. Additionally, the global realignment plan resulted in restructuring and other charges in jurisdictions which have valuation allowances against tax loss carryforwards, so a tax benefit has not been recognized in the financial statements.

7. Earnings Per Share

Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is calculated by dividing net income by the weighted average shares outstanding plus share equivalents that would arise from the exercise of stock options, vesting of restricted common shares, and contingently issuable shares in connection with the Company’s acquisitions. During the
three months ended June 30, 2016
and
2015
, an aggregate of
4.2 million
and
3.1 million
options and restricted common shares, respectively, and during the
six months ended June 30, 2016
and
2015
, an aggregate of
4.2 million
and
3.3 million
options and restricted common shares, respectively, were excluded from the calculation as these options and restricted common shares were anti-dilutive. The computations of basic and diluted earnings per common share for
three and six
months ended
June 30, 2016
and
2015
are as follows (in thousands, except per share amounts):

12

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

Three Months Ended June 30,

Six Months Ended June 30,

2016

2015

2016

2015

(as revised)

(as revised)

Numerator:

Net income (loss)

$

(2,324

)

$

3,655

$

(5,017

)

$

3,930

Denominator:

Weighted-average shares outstanding
–
basic

53,411

52,588

53,278

52,651

Effect of dilutive securities:

Employee and director stock options and restricted common shares

—

632

—

768

Contingently issuable shares

—

992

—

496

Weighted-average shares outstanding
–
diluted

53,411

54,212

53,278

53,915

Basic earnings (loss) per share

$

(0.04

)

$

0.07

$

(0.09

)

$

0.07

Diluted earnings (loss) per share

$

(0.04

)

$

0.07

$

(0.09

)

$

0.07

8. Accumulated Other Comprehensive Loss

The table below presents changes in the components of accumulated other comprehensive loss for the
three and six
months ended
June 30, 2016
and
2015
(in thousands):

Three Months Ended June 30,

2016

2015

Foreign currency translation adjustments

Foreign currency translation adjustments

Balance, beginning of period

$

(14,463

)

$

(11,843

)

Other comprehensive income (loss) before reclassifications

(1,390

)

2,098

Net current-period other comprehensive income (loss)

(1,390

)

2,098

Balance, end of period

$

(15,853

)

$

(9,745

)

Six Months Ended June 30,

2016

2015

Foreign currency translation adjustments

Foreign currency translation adjustments

Balance, beginning of period

$

(13,993

)

$

(5,401

)

Other comprehensive loss before reclassifications

(1,860

)

(4,344

)

Net current-period other comprehensive loss

(1,860

)

(4,344

)

Balance, end of period

$

(15,853

)

$

(9,745

)

9. Related Party Transactions

The Company provides print procurement services to Arthur J. Gallagher & Co. J. Patrick Gallagher, Jr., a member of the Company’s Board of Directors, is the Chairman, President and Chief Executive Officer of Arthur J. Gallagher & Co. and has a direct ownership interest in Arthur J. Gallagher & Co. The total amount billed for such print procurement services during the
three months ended June 30, 2016
and
2015
was
$0.5 million
and
$0.5 million
, respectively, and
$1.0 million
and
$0.9 million
during the
six months ended June 30, 2016
and
2015
, respectively. Additionally, Arthur J. Gallagher & Co. provides insurance brokerage and risk management services to the Company. As consideration of these services, Arthur J. Gallagher & Co. billed the Company
$0.1 million
and
$0.1 million
for the
three months ended June 30, 2016
and
2015
, respectively, and
$0.2 million
and
$0.1 million
during the
six months ended June 30, 2016
and
2015
, respectively. The net amount receivable from Arthur J. Gallagher & Co. at
June 30, 2016
was
$0.5 million
.

13

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

10. Fair Value Measurement

ASC 820 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on observable or unobservable inputs to valuation techniques that are used to measure fair value. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon its own market assumptions.

Level 2:
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable and market-corroborated inputs, which are derived principally from or corroborated by observable market data.

•

Level 3:
Inputs that are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

The Company's potential contingent consideration payments relating to acquisitions occurring subsequent to January 1, 2009 are its only Level 3 liabilities as of
June 30, 2016
and
December 31, 2015
. The fair value of the liabilities determined by this analysis is primarily driven by the probability of reaching the performance measures required by the purchase agreements and the associated discount rates. Probabilities are estimated by reviewing financial forecasts and assessing the likelihood of reaching the required performance measures based on factors specific to each acquisition as well as the Company’s historical experience with similar arrangements. If an acquisition reaches the required performance measure, the estimated probability would be increased to
100%
and reclassified to Due to seller, and if the measure is not reached, the probability would be reduced to reflect the amount earned, if any, depending on the terms of the agreement. Discount rates are estimated by using the local government bond yields plus the Company’s credit spread. A one percentage point increase in the discount rate across all contingent consideration liabilities would result in a decrease to the fair value of approximately
$0.2 million
.

The following table sets forth the Company’s financial assets and financial liabilities measured at fair value on a recurring basis and the basis of measurement at
June 30, 2016
and
December 31, 2015
(in thousands):

At June 30, 2016

Total Fair Value Measurement

Quoted Prices in Active Markets for Identical Assets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Assets:

Money market funds
(1)

$

—

$

—

$

—

$

—

Liabilities:

Contingent consideration

$

(18,560

)

$

—

$

—

$

(18,560

)

At December 31, 2015

Total Fair Value Measurement

Quoted Prices in Active Markets for Identical Assets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Assets:

Money market funds
(1)

$

667

$

667

$

—

$

—

Liabilities:

Contingent consideration

$

(22,162

)

$

—

$

—

$

(22,162

)

(1)

Included in cash and cash equivalents on the balance sheet.

14

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

The following table provides a reconciliation of the beginning and ending balances for the liabilities measured at fair value using significant unobservable inputs (Level 3) (in thousands):

Adjustments to original contingent consideration obligations recorded were the result of using revised financial forecasts and updated fair value measurements. These changes are recognized within operating expenses on the condensed consolidated statement of comprehensive income (loss).

(2)

Changes in the contingent consideration liability which are caused by foreign exchange rate fluctuations are recognized in other comprehensive loss.

11. Commitments and Contingencies

In October 2013, the Company removed the former owner of Productions Graphics from his role as President of Productions Graphics, the Company’s French subsidiary. He had been in that role since the Company’s 2011 acquisition of Productions Graphics, a European business then principally owned by him. In December 2013, the former owner of Productions Graphics initiated a wrongful termination claim in the Commercial Court of Paris seeking approximately
€0.7 million
(approximately
$1.0 million
) in fees and damages. In anticipation of this claim, in November 2013, he also obtained a judicial asset attachment order in the amount of
€0.7 million
(approximately
$1.0 million
) as payment security; the attachment order was confirmed in January 2014, and the Company filed an appeal of the order. In March 2015, the appellate court ruled in the Company’s favor in the attachment proceedings, releasing all attachments. The Company disputes the allegations of the former owner of Productions Graphics and intends to vigorously defend these matters. In February 2014, based on a review the Company initiated into certain transactions associated with the former owner of Productions Graphics, the Company concluded that he had engaged in fraud by inflating the results of the Productions Graphics business in order to induce the Company to pay him
€7.1 million
in contingent consideration pursuant to the acquisition agreement. In light of those findings, in February 2014 the Company filed a criminal complaint in France seeking to redress the harm caused by his conduct and this proceeding is currently pending. In addition, in September 2015 the Company initiated a civil claim in the Paris Commercial Court against the former owner of Productions Graphics, seeking civil damages to redress these same harms. In addition to these pending matters, there may be other potential disputes between the Company and the former owner of Productions Graphics relating to the acquisition agreement. The Company had paid
€5.8 million
(approximately
$8.0 million
) in fixed consideration and
€7.1 million
(approximately
$9.4 million
) in contingent consideration to the former owner of Productions Graphics; the remaining maximum contingent consideration under the acquisition agreemen
t
was
€34.5 million
(approximately
$37.6 million
) and the Company has determined that none of this amount was earned and payable.

In January 2014, a former finance employee of Productions Graphics initiated wrongful termination and overtime claims in the Labor Court of Boulogne-Billancourt, and he currently seeks damages of approximately
€0.6 million
(approximately
$0.8 million
). The Company disputes these allegations and intends to vigorously defend these matters. In addition, the Company’s criminal complaint in France, described above, seeks to redress harm caused by this former employee in light of his participation in the fraudulent transactions described above. The labor claim has been stayed in deference to the Company’s related criminal complaint.

In February 2014, shortly following the Company’s announcement of its intention to revise certain historical financial statements, an individual filed a putative securities class action complaint in the United States District Court for the Northern District of Illinois entitled
Van Noppen v. InnerWorkings et al
. The complaint, as amended in July 2014, alleges that the Company and certain executive officers violated federal securities laws by making materially false or misleading statements or omissions,

15

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

and by engaging in a scheme to defraud purchasers of securities, relating to the Company’s financial results and prospects. The purported misstatements and scheme relate to the Company’s inside sales initiative and the Productions Graphics business based in France. The complaint seeks unspecified damages, interest, attorneys’ fees and other costs. The Company and individual defendants dispute the claims. On September 29, 2014, the Company and individual defendants filed a motion to dismiss the complaint for failure to state a claim. On September 30, 2015, the Court granted in part and denied in part the motion to dismiss, resulting in the dismissal with prejudice of all claims relating to the inside sales initiative. On March 18, 2016, the parties reached an agreement in principle to settle the litigation. The settlement, which remains subject to final Court approval, provides for payment to the class of
$6.0 million
, including plaintiff’s attorneys’ fees, in exchange for a full and final release, and includes a denial of liability or any wrongdoing by the Company and the individual defendants. The settlement payment will be fully paid by the Company’s insurance carrier. On December 12, 2014, the Company received a derivative demand letter on behalf of Tom Turberg, a purported stockholder, demanding that the Company’s Board of Directors investigate and take action on behalf of the Company against the executive officers named in the
Van Noppen
action as well as certain past and current members of the Audit Committee of the Board of Directors. The demand letter’s allegations relate to (i) the Company’s revisement of financial statements for the fourth quarter of 2011 through the third quarter of 2013, (ii) the Company’s use of gross revenue accounting, (iii) incentive compensation paid to executive officers in 2011 and 2012, (iv) allegations in the
Van Noppen
action, and (v) typographical errors in the 2013 Form 10-K. The demand letter has been forwarded to the Company’s Board of Directors for its review and handling, and a Committee of independent directors of the Board of Directors is reviewing and evaluating the matters raised in the letter.

In March 2016, Capgemini America, Inc. (“Capgemini”) filed a complaint against the Company in the United States District Court for the Northern District of Illinois, alleging breach of contract and unjust enrichment in connection with the Company’s termination of Capgemini’s services under an agreement requiring Capgemini to provide certain business process outsourcing services to the Company. The complaint seeks damages of
$2.4 million
, interest, costs, and attorney’s fees. The Company disputes the claims and intends to vigorously defend the matter. In April 2016, the Company filed an answer, affirmative defenses and counterclaims against Capgemini. The Company’s counterclaims allege fraud in the inducement, Illinois Consumer Fraud Act liability, and breach of contract, and seek compensatory and punitive damages, costs, and attorney’s fees in an amount to be determined. In June 2016, the parties entered into a confidential settlement agreement in which the parties mutually released each other from all claims and the lawsuit was dismissed with prejudice. The settlement did not have a material impact on the Company’s financial position or results of operations.

12. Revolving Credit Facilities

The Company entered into a Credit Agreement, dated as of August 2, 2010, subsequently amended most recently as of September 25, 2014, among the Company, the lenders party thereto and Bank of America, N.A., as Administrative Agent (the “Credit Agreement”). The Credit Agreement includes a revolving commitment amount of
$175 million
in the aggregate with a maturity date of
September 25, 2019
, and provides the Company the right to increase the aggregate commitment amount by an additional
$50 million
. Outstanding borrowings under the revolving credit facility are guaranteed by the Company’s material domestic subsidiaries, as defined in the Credit Agreement. The Company’s obligations under the Credit Agreement and such domestic subsidiaries’ guaranty obligations are secured by substantially all of their respective assets. The ranges of applicable rates charged for interest on outstanding loans and letters of credit are
125
-
250
basis point spread for letter of credit fees and loans based on the Eurodollar rate and
25
-
150
basis point spread for loans based on the base rate.

The terms of the Credit Agreement include various covenants, including covenants that require the Company to maintain a maximum leverage ratio and a minimum interest coverage ratio. The Credit Agreement requires the Company to maintain a leverage ratio of no more than
3.00
to 1.0 for the quarter ended
June 30, 2016
and
3.00
to 1.0 for each period thereafter. The Company is also required to maintain an interest coverage ratio of no less than
5.00
to 1.0. The Company is in compliance with all debt covenants as of
June 30, 2016
.

At
June 30, 2016
, the Company had
$40.3 million
of unused availability under the Credit Agreement and
$0.7 million
of letters of credit which have not been drawn upon.

The book value of the debt under this Credit Agreement is considered to approximate its fair value as of
June 30, 2016
as the interest rate on the loan is in line with current market rates.

On February 22, 2016, the Company entered into a Revolving Credit Facility (the “Facility”) with Bank of America N.A. to support ongoing working capital needs of the Company. The Facility includes a revolving commitment amount of
$5.0 million

16

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

whereby maturity dates vary based on each individual drawdown. Outstanding borrowings under the Facility are guaranteed by the Company’s assets. The applicable interest rate is
110%
of the People’s Bank of China’s base rate. The terms of the Facility

include limitations on use of funds for working capital purposes as well as customary representations and warranties made by the Company. At June 30, 2016, the Company had
$4.7 million
of unused availability under the Facility.

13.
Share Repurchase Program

On February 12, 2015, the Company announced that its Board of Directors approved a share repurchase program authorizing the repurchase of up to an aggregate of
$20 million
of its common stock through open market and privately negotiated transactions over a
two
-year period. The timing and amount of any share repurchases will be determined based on market conditions, share price and other factors, and the program may be discontinued or suspended at any time. Repurchases will be made in compliance with SEC rules and other legal requirements.

During the
three and six months ended June 30, 2016
, the Company did not repurchase any shares of its common stock. During the
three months ended June 30, 2015
, the Company repurchased
219,163
shares of its common stock for
$1.4 million
in the aggregate at an average cost of
$6.38
per share. During the six months ended June 30, 2015, the Company repurchased
763,787
shares of its common stock for
$4.9 million
in the aggregate at an average cost of
$6.41
per share. Shares repurchased under this program are recorded at acquisition cost, including related expenses.

14. Business Segments

Segment information is prepared on the same basis that our Chief Executive Officer, who is our chief operating decision maker (“CODM”), manages the segments, evaluates financial results, and makes key operating decisions. In fiscal year
2015
, segments were organized and managed by the CODM as
three
business segments: North America, including the United States and Canada; EMEA, including operations in the United Kingdom, continental Europe, the Middle East, Africa and Asia; and LATAM, including operations in Mexico, South America and Central America. Effective in the first fiscal quarter of
2016
, the Company implemented changes to the organizational structure of the Latin America and EMEA segments which included combining the two segments under single management and managing those businesses as one segment. In conjunction with this change, the CODM now manages the results of the Company as
two
business segments: North America and International. The North America segment includes operations in the United States and Canada; the International segment includes all other operations across Europe, Asia, Mexico, Central America and South America; Other consists of intersegment eliminations, shared service activities and unallocated corporate expenses. All transactions between segments are presented at their gross amounts and eliminated through Other. Prior period amounts have been restated to reflect this change.

Management evaluates the performance of its operating segments based on revenues and Adjusted EBITDA, which is a non-GAAP financial measure. The accounting policies of each of the operating segments are the same as those described in the summary of significant accounting policies in Note 1. Adjusted EBITDA represents income from operations excluding depreciation and amortization, stock-based compensation expense, income/expense related to changes in the fair value of contingent consideration liabilities and other items as described below. Management does not evaluate the performance of its operating segments using asset measures.

The table below presents financial information for the Company’s reportable segments and Other for the
three and six
month periods noted (in thousands):

17

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

North America

International

Other

Total

Three Months Ended June 30, 2016:

Revenue from third parties

$

177,006

$

92,214

$

—

$

269,220

Revenue from other segments

—

3,742

(3,742

)

—

Total revenue

177,006

95,956

(3,742

)

269,220

Adjusted EBITDA
(1)

15,793

6,103

(7,103

)

14,793

Three Months Ended June 30, 2015 (as revised):

Revenue from third parties

$

168,936

$

83,291

$

—

$

252,227

Revenue from other segments

—

3,256

(3,256

)

—

Total revenue

168,936

86,547

(3,256

)

252,227

Adjusted EBITDA
(1)

14,762

4,873

(6,223

)

13,412

North America

International

Other

Total

Six Months Ended June 30, 2016:

Revenue from third parties

$

367,009

$

173,283

$

—

$

540,292

Revenue from other segments

—

7,509

(7,509

)

—

Total revenue

367,009

180,792

(7,509

)

540,292

Adjusted EBITDA
(1)

31,799

10,038

(15,350

)

26,487

Six Months Ended June 30, 2015 (as revised):

Revenue from third parties

$

339,737

$

154,586

$

—

$

494,323

Revenue from other segments

—

5,453

(5,453

)

—

Total revenue

339,737

160,039

(5,453

)

494,323

Adjusted EBITDA
(1)

29,696

5,951

(14,023

)

21,624

(1)

Adjusted EBITDA, which represents income from operations with the addition of depreciation and amortization, stock-based compensation expense, change in the fair value of contingent consideration liabilities and certain legal settlements, is considered a non-GAAP financial measure under SEC regulations. Income from operations is the most directly comparable financial measure calculated in accordance with GAAP. The Company presents this measure as supplemental information to help investors better understand trends in its business results over time. The Company’s management team uses Adjusted EBITDA to evaluate the performance of the business. Adjusted EBITDA is not equivalent to any measure of performance required to be reported under GAAP, nor should this data be considered an indicator of the Company’s overall financial performance and liquidity. Moreover, the Adjusted EBITDA definition the Company uses may not be comparable to similarly titled measures reported by other companies.

The table below reconciles the total of the reportable segments' Adjusted EBITDA and the Adjusted EBITDA included in Other to income before income taxes (in thousands):

Three Months Ended June 30,

Six Months Ended June 30,

2016

2015

2016

2015

(as revised)

(as revised)

Adjusted EBITDA

$

14,793

$

13,412

$

26,487

$

21,624

Depreciation and amortization

(4,721

)

(4,266

)

(9,316

)

(8,357

)

Stock-based compensation expense

(1,117

)

(1,567

)

(2,358

)

(3,628

)

Change in fair value of contingent consideration

(7,276

)

(676

)

(9,187

)

(990

)

Restructuring and other charges

(623

)

—

(3,967

)

—

Income from operations

1,056

6,903

1,659

8,649

Total other expense

(670

)

(1,065

)

(1,894

)

(2,106

)

Income (loss) before income taxes

$

386

$

5,838

$

(235

)

$

6,543

18

InnerWorkings, Inc. and subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Three and Six Months Ended June 30, 2016

The table below presents total assets for the Company’s reportable segments and Other as of
June 30, 2016
and
December 31, 2015
(in thousands):

During the financial statement close for the period ended June 30, 2016, the Company identified errors that affect the current and prior years related to the recognition of non-executive bonus compensation expense under the Company's bonus plan. Historically, the Company has recorded the expense for non-executive bonuses during the quarter of payment, usually the second quarter following the service year, rather than over the course of the relevant service year. The Company now will accrue non-executive bonus expense during the course of the relevant service year when the amount is estimable and probable.

The Company has evaluated the effects of this correction in accounting for non-executive bonuses on its historical financial statements and concluded that none of the periods in the previously issued financial statements are materially misstated. Nonetheless, because correcting for the cumulative effect of the historical errors in the current period would have been material to the current period, the Company has revised its historical consolidated financial statements for the annual periods ended December 31, 2013, December 31, 2014 and December 31, 2015 and interim periods ended March 31, 2014, June 30, 2014, September 30, 2014, December 31, 2014, March 31, 2015, June 30, 2015, September 30, 2015, December 31, 2015 and March 31, 2016 to reflect the correction of this immaterial error in this Form 10-Q.

The following schedules reconcile the amounts as originally reported in the applicable financial statement to the corresponding revised amounts.